Securing Your Future, One Policy at a Time

No Regulation, Tax Shelter | RED FLAG

Passage of the Tax Equity and Fiscal Responsibility Act (TEFRA) in 1982 established that universal life insurance was, in fact, life insurance. The law defined characteristics of life insurance that must be present.

The Deficit Reduction Act (DEFRA) of 1984 coordinated with language laid out in TEFRA from two years before to establish specific rules about what life insurance was and what life insurance was not.

More specifically, upon DEFRA’s passage, we now had specific limitations on premium size relative to an outstanding death benefit. That Premium to Death Benefit ratio was now the deciding factor as to what qualified or disqualified a life insurance contract as life insurance.

DEFRA included the creation of two tests that would be the guideline moving forward for life insurance qualification & created the inception of the 7702 tax code.

The Technical and Miscellaneous Revenue Act (TAMRA) of 1988 laid out one additional restriction on life insurance. A new test that limited premiums paid to a life insurance policy to the premiums needed to cover all guarantees of the contract spread out over a seven-year period. (This is why we often call it the 7-Pay Test.)

If a policyholder violated this rule by paying more than this amount, he or she didn’t lose his/her policy’s status as life insurance per se. Instead, the policy was reclassified as a Modified Endowment Contract (MEC).

-Life insurance illustrations could be presented in the same manner as annuities, using this “cherry picked” sequence of returns.

-Using these “cherry picked” sequence of returns combined with a low loan rate (in a low interest environment), allowed the carriers to show very large arbitrage numbers.

-Deceptive illustrations. Using returns from a timeframe when interest rates were high (meaning higher caps and pars), and putting them against loans from a more current, lower interest rate environment.

-Expanded upon the previous guidelines to further restrict what can be shown on life insurance illustrations.

-By limiting how products with interest-linked rate enhancements can be illustrated, essentially doing away with the multiplier concept.

-Further restricted the amount of arbitrage that could be shown, lowering the acceptable illustrated arbitrage from 1% to .50%.

-The Consolidated Appropriations Act revised and lowered the required corridor for life insurance under federal guidelines.

-The same premium contribution could now have a significantly lower face amount attached to it.  

-Huge benefit to cash accumulation and income planning because you have less stress on the policy from the cost of the death benefit itself.